It’s one of the most common mistakes that investors – individuals as well as the so-called “smart money” – make…
Investing at home seems like a good idea. It’s familiar and comfortable. If you live in Tokyo, for example, you see the Nikkei quoted every night on the news. If you’re based in London, you’re used to watching and reading about the national benchmark FTSE 100. And if you’re American, U.S. markets are probably your first investment stop. Investing locally means investing in what you know – which is generally smart.
So it’s not surprising that most people invest mostly in their home market.
Here’s the thing: It’s not only individual investors… institutional fund managers are guilty of bias, too.
Institutional investors put all their eggs in one basket
The graph below shows the asset allocation of institutional investors’ (that is, big investment funds, pensions funds, and hedge funds, among others) by continent in 2014. In short, it shows continents that funds in different areas are invested in. (Data from 2014 may seem ancient, but investment allocations like this don’t change very fast).
As the above show, in North America, 75 percent of institutional investors’ money was invested in North America. Just 13 percent was invested in Europe… and a tiny 8 percent in Asia. Meanwhile, in Europe, 61 percent of institutional investors’ money remained in their home continent, with 20 percent in North America and just 13 percent in Asia.
Asia comes in with the highest home-region allocation, with 85 percent of institutional investors’ funds staying at home. That means institutional investors have allocated just 6 percent of their investments to North America, just 5 percent to Europe… and 4 percent to other areas.
But that’s just the tip of the iceberg. This is a mistake just about every investor makes…
Individual investors are guilty of home country bias too
As shown in the graph below, the average American with a stock portfolio has 79 percent of their money in U.S.-listed stocks. Investors in Japan put about 55 percent of their money in Japan-listed stocks. People in Australia have two-thirds of their portfolio in local shares.
That might be what they’re comfortable with. But from a portfolio diversification perspective, it’s like juggling live dynamite.
As the graph below shows, American stocks account for only 51 percent of total global market capitalisation (that is, the value of all stock markets in the world). So American investors are a lot more exposed to U.S.-listed companies than – based on a breakdown of the world’s markets – they should be.
Japanese investors are even more lopsided in their home preference – Japan accounts for only 7 percent of the world’s stock market, yet they invest 55 percent of their money at “home”. And Australians put 66 percent of their money into their own market – which is just two percent of the world’s markets.
And Singapore’s stock market is only 0.4 percent of the world total, but Singaporeans invest about 39 percent of their money in domestic equities.
Why do investors do this?
As I mentioned, they’re investing in what they know, which (all else being equal) makes sense. Also, studies have shown that domestic investors tend to be more optimistic about the local economy than foreign investors – so local investors think they’re investing where the growth is.
And local investors face fewer tax hassles when buying domestic shares, and less foreign currency risk. Crucially, investors often trust companies and stocks outside their borders less than they do those in their own country (even if the “foreign” market is bigger and less volatile than the local market).
How geographic diversification helps
A portfolio that isn’t sufficiently diversified is riskier than one that is well diversified. And geographical diversification is important, as we showed here. Since different markets outperform at different times, even though they all tend to move in the same general direction, having money invested in a range of geographical markets can boost your returns.
Make sure to assess the home bias of your own portfolio. If you have a severe case of home country bias, it would be wise to consider moving some of your money elsewhere. Your portfolio can only benefit from being a little more cosmopolitan.